Book Review: How Markets Really Work

Do you want to make money in the short run? Beat the markets? This could be the book for you.

I am a longer-term investor, but  this book looks at a lot of strategies that are commonly understood by traders, and finds that the traders are wrong.

What are we talking about?  For the most part the book indicates that momentum strategies fail in the short run.  That’s not as radical as it sounds because the academic literature documents a short term reversal effect (one month) for stocks that are moving dramatically.

But this book shows the effect in many ways, looking at:

  • Changes vs 5 & 10-day highs/lows
  • When markets make higher highs or lower lows over three days
  • Days up or down in a row
  • Market Breadth
  • Large move up or down
  • Number of 52-week highs versus lows

When these factors are strong, the market tends to be weak in the short run.

Then there are these factors:

  • Volume
  • Put/Call ratio

They have little effect on future returns in the short run.  But what does have effect in the short run?

  • VIX
  • RSI(2)
  • Low Vol beats High Vol

High VIX relative to trend indicates a short-term rally, as does a low RSI(2) score.  As for the low volatility, it takes a different approach, segmenting the market by historical  volatility, and no surprise, low volatility wins.

At the end the book tries to draw all of the ideas into a trading strategy, but I have no idea how good it is, because I have no idea how many strategies they tested before announcing the one that fit the past the best.

This is an audacious book, but what would be needed to make this a great book is not what happens over the next five days, but what happens over the next year.  Capital does not recycle annually, much less weekly.

Most strategies that involve a lot of trading fail; this book may fall into that bucket.

Quibbles

Graph 3-7 is blank.

This is a very short book, with many graphs and tables taking up 80% of the book.  That can be a weakness or strength, depending on your point of view.

Who would benefit from this book: Those who want to improve their trading of the markets in the very short run would benefit from this book.  If you want to, you can buy it here: How Markets Really Work: Quantitative Guide to Stock Market Behavior (Bloomberg Financial).

Full disclosure: The publisher asked me if I wanted the book, so I asked for the book and he sent it to me.

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